Summary – Twist Again, Like We Did Last Summer!

The Fed voted this week to extend “Operation Twist” through year end with a desire to keep term interest

rates low or perhaps drive them lower. Essentially, the Fed is selling short-term Treasuries and buying long-

term Treasuries in hopes the reduced supply of longer term bonds drives yields down.

What they don’t seem to understand is the fact “high” interest rates are not prohibiting activity today. In

fact, what is inhibiting activity is the tremendous uncertainty coming out of the rest of Washington. Fears

surrounding everything from fiscal and regulatory reform to social policies are driving the transactors

underground. European uncertainty, of course, does not help.

To Bernanke’s credit, he has brought up this fact several times over recent months, all but stating there is

only so much the Fed can do.

What’s Important…

Smaller “twist” leaves markets yawning. The $267 billion Maturity Extension Program announced this week

will run through the end of 2012, sitting at just 67 percent of the initial version. Market reaction was muted

with participants feeling the Fed had to do “something,” but that this effort is just another chapter.

The door remains open for additional stimulus. In the accompanying statement to this week’s meeting, the

FOMC said “inflation over the medium turn will run at or below the rate that it judges consistent with its

dual mandate.” This essentially means they are not worried about price pressures and therefore may ramp

up activity should they see the need in the future.

European challenges are an additional headache for the Fed. Recent turmoil in Europe is slowing economies

across the globe, even recently affecting emerging markets. The eventual outcome in Europe cannot come

soon enough, and doesn’t look to be a pleasant one. This creates more confusion as the U.S. remains the

world’s safe haven even during today’s subpar performance. This only complicates the Fed’s job given their

primary tool – money supply – is experiencing uncertain flows.

Federal Reserve options are many, but focus on lower rates blunts their effect. There are still many ways the

Fed can manipulate monetary policy, but all of them focus on the price of credit – interest rates.

Unfortunately at today’s rates, it is hard to believe the cost of credit is prohibiting activity.

Bernanke has made it clear the Fed cannot offset January’s “fiscal cliff.” Stressing the importance of a solid

fiscal policy, Bernanke has increased comments that Congress needs to address the fiscal cliff coming in

January, because going over that cliff will dominate any Fed action.

Quick Hits: The Fed June 21, 2012

What to Look for…

After a fairly solid showing in the first quarter, the economy is slowing down. The Fed’s latest action is

likely only the next chapter in what will be a series of steps later this summer and into the fall as the

economy continues to slow. A falling stock market will accelerate these moves as it seems the Fed is

paying particular attention to equities as an indicator of overall economic health.

A Picture is Worth…

The black bars above show Treasury issue holdings at the Fed. As you can see, the Fed has very few short-term Treasuries and owns mostly longer-term securities. This why the “twist” was smaller – they simply don’t have that many short Treasuries to sell.

Written by:

Joe Morgan Chief Investment Officer SVB Asset Management @SVBJoeMorgan jmorgan@svb.com

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